Currencies: Base and Counter
As opposed to trading in other markets, Forex is only associated with two products that are technically being traded simultaneously, with the one being bought while the other currency is sold. That is stipulated to the fact that the cost of one currency is traditionally predetermined by its relation to another. Foreign exchange is always placed in pairs, for instance, EUR/USD (Euro vs. US dollar), or GBP/USD (Great Britain pound vs. US dollar). The first currency pair cost is known as the base currency, and the second is called the counter currency.
Leverage Definition and Basic Principles
Many market players consider forex trading to be a rewarding opportunity for the reason of big leverage volume traders can have at their disposal. No matter what the quantity of one asset is having an effect on the more significant amount of another asset. In the Forex industry, traders can open larger sized positions regardless the amount of their own deposited funds. Therefore, the size of the operations exercised is not restricted by the initial down payment in your bank account because of the increased rate of allowed leverage.
Experts specify leverage in ratio. For instance, a 70:1leverage ratio indicates that for every dollar deposited in your account, you can open the position worth 50$. The fact is a dealer would only need to make the down payment worth 2 percent of the trade to go on operating with a particular position (1/50 = 00.2 =2%). Let us assume you need to trade 100,000$ of currency. It would only take 2,000$ to invest.
On the other side, dealing with fixed assets would restrict a trader by the number of funds in that currency he/she currently has at the disposal within the bank account.
Leverage scale of every currency pair may significantly differ when it comes to forex trading activity. Dealers should bear in mind that leverage settings are only dependable on the altering market conditions.
Nevertheless, it has vital importance to know everything about both the pros and cons associated with using leverage. When making gains on leveraged funds, the possible returns can be substantial. On the other hand, if the market leads the opposite direction to one’s operation, potential losses can appear to be equally large. Due to this fact, making the leverage scale increased causes the higher risk of an operation. It only takes practical training, education and sufficient experience to identify cases correctly when leverage should be used and how far.
Going long and short in the currency trading
On the fact that currencies are traditionally traded in pairs, by opening trading positions traders are referred to as “going long” on one currency and “going short” on the other one. For instance, if you sold one standard lot (that is equal to 100,000 units) by using EUR/USD currency pair, Euros would have been exchanged for US dollars with “short” on Euros and long on Dollars.
A dealer believes that the Euro will demonstrate the strengthening tendency against the Dollar, and makes a decision to ‘purchase,’ or in other words ‘go long’ on €10,000, at a price point estimated at 1.4989, with a leverage scale of 1:50.
In such a case the initial down payment necessary to perform the trade is €299.78 (10,000 x 1.4989/50)
Fortunately, the Euro strengthens against the US dollar. After that, the trader decides to ‘sell’ €10,000 aiming at closing the operation, at a price of 1.5076 which is considered as a rise of 87 percentage points above the opening position.
The profit calculation will be as follows: (1.5076-1.4989) x 10,000 = $87
On the other hand, let us assume if the Euro weakened against the Dollar – that is contrary to the dealers’ expectations – with the striking price dropping to 1.4902, some traders are likely to ‘sell’ at the mentioned point closing the €10,000 operation.
In this case, a dealer would face a -$87 loss (1.4989-1.4902) x 10,000.
Let us assume, after using such a sound approach and carrying out the analysis, a trader expects that the American dollar is soon to be strengthened against the Euro. Hence a dealer decides to go short on EUR/USD – buying dollars in exchange for Euros. The pair is currently trading at ask rate of 1.6764/1.6770. The dealer sets the high limit leverage scale of this currency pair, 200:1 ‘selling’ $10,000 at the rate of 1.6770.
The initial deposit is calculated by multiplying the amount of currency to buy and counter currency exchange rate/leverage scale.
Taking this into consideration, the initial deposit (10,000 x 1.6770/200) requires a payment of $83.85. In the short term run, the market moves the way as predicted by the trader, and the US dollar shows the strengthening tendency against the Euro.
The bid/ask rate becomes 1.6811/1.6817, and the trader makes a decision to close the trade here. The trader ‘buys back’ the €10,000 at a price of 1.6811.
The trader opened at 1.6770 and closed at 1.6811, an increase of 41 percentage points (pips).
The profit is calculated the following way: (price closed at deducting the point price opened at) times amount of currency purchased.
By doing that, the dealer has gained $41 from the operation [(1.6811-1.6770) x $10,000].
Trading scenarios may differ but being aware of basic currency trading principles may result in the winning outcomes.